Does BoE’s hawkish lurch nod to sterling crisis?
As the Bank of England sends its strongest signal to date that the first interest rate hike in a decade is approaching, could Britain be heading towards its first sterling crisis in a quarter of a century?
At first glance, there appear to be few parallels between now and 1992, when George Soros famously “broke the Bank of England” and the pound chalked up what was then its biggest one-day loss of the floating exchange rate era.
That dubious record was smashed on June 24, 2016, after Britain voted to leave the European Union, but there has been little talk since of a “sterling crisis”, and the weaker pound has been broadly viewed as a welcome safety valve, keeping asset markets attractive to foreign investors while buoying export and corporate earnings without forcing up interest rates.
So what then constitutes a sterling crisis? And does the Bank’s sudden hawkish turn to offset the inflationary effects of a weak pound bring Britain closer to one?
There’s no agreed definition of a sterling “crisis”, but one common element is that persistent sterling selling or weakness forces up interest rates, hits asset markets and potentially hastens recession. In effect, rates are forced higher to defend the pound or to bring imported inflation under control, regardless of the economy’s ability to withstand that monetary tightening.
Some might argue that’s now happening with a 15-month lag, although no one at the Bank will ever admit that the exchange rate determines policy, despite it being the main reason the Bank is failing in its sole mandate: controlling inflation.
There have been at least four sterling crises in the last 50 years - 1967, 1976, the mid 1980s and 1992 - where interest rates were jacked up aggressively in ultimately unsuccessful attempts to defend the currency. A doubling of interest rates from a record low 0.25 percent currently to 0.5 percent would only reverse the emergency cut shortly after the Brexit referendum last year. Even another quarter point hike would be laughably miniscule when set against the steep rate increases of crises past.
But it would represent a doubling or trebling of official borrowing costs, greater magnitudes of increase than those four crises past. — Reuters